Fitch upgrades ratings of Mangistau Electricity Distribution Network Company (Kazakhstan); outlook Stable

November 22. KASE

Fitch upgrades ratings of Mangistau Electricity Distribution Network Company (Kazakhstan); outlook StableFitch Ratings has upgraded Mangistau Electricity Distribution Company JSC’s (MEDNC) Long-term foreign currency Issuer Default Rating (IDR) to ‘BB+’ from ‘BB’. The Outlook on the Long-term IDR is Stable. A full list of rating actions is provided below.

KEY DRIVERS

– Sovereign Rating Upgrade

The upgrades reflect Fitch’s upgrade of Kazakhstan’s Long-term foreign and local currency IDRs to ‘BBB+’ from ‘BBB’ and to ‘A-‘ from ‘BBB+’, respectively (see Fitch Upgrades Kazakhstan to ‘BBB+’ dated 20 November 2012 at www.fitchratings.com .

– State Support

MEDNC’s ratings are linked to those of Kazakhstan, but notched down by three notches to reflect that little indication has been given by MEDNC’s parent, JSC Samruk-Energo (S-E), that it will provide timely financial assistance to MEDNC in case of need. The notching reflects the fact that S-E has not provided tangible financial assistance to MEDNC in the past three years. The dividend payout ratio was set back to 50% of net profit (or KZT83m) for 2011. Management expects the dividend payout to remain 50% in the medium term. The agency believes that this will not put significant pressure on the rating. Fitch views MEDNC’s standalone business and financial profile as commensurate with a weak ‘BB-‘ rating.

S-E is not actively pursuing a reduction of its stake in MEDNC. However, it does not view MEDNC as strategic. The ratings are based on the assumption that S-E will retain at least majority ownership of MEDNC over the rating horizon.

– Near-Monopoly Position

MEDNC’s credit profile is supported by its near-monopoly position in electricity transmission and distribution in the Region of Mangistau, one of Kazakhstan’s strategic oil & gas regions. It is also underpinned by prospects for economic development and expansion in the region, in relation to both oil & gas and transportation, the cost-plus-based tariff mechanism under which it operates. MEDNC also benefits from limited foreign exchange and absence of interest rate risks.

– Small Scale, High Customer Concentration

The ratings are constrained by MEDNC’s small scale of operations limiting its cash flow generation capacity, high exposure to a single industry (oil & gas) and, within that, high customer concentration (the top four customers represented over 65% of 2011 revenue). The latter is somewhat mitigated by the state ownership of major customers (Ozenmunaigaz and Kaz GPZ are 100% subsidiaries of KazMunaiGaz National Company; and Mangistaumunaigas and Karazhanbasmunai are 50% owned by KazMunaiGaz National Company) and prepayment terms under sales agreements.

– Stable Cash Flow From Operations Expected

Fitch expects MEDNC to continue generating solid and stable cash flow from operation over 2012-15. Free cash flows are likely to remain positive in 2012, but may turn negative in 2013, mainly driven by substantial capex plans. For 2012, Fitch estimates MEDNC’s cash flow from operations at about KZT1.2bn, before capex (KZT472m) and dividends (KZT83m).

– Capex Driven Leverage Increase Expected

MEDNC’s funds flow from operations (FFO) adjusted leverage for 2011 slightly improved to 2.2x from 2.9x at end-2010. This ratio is expected to remain below 3x in 2012-2013 and to increase to around 3x in 2014, driven by an increase in capex. FFO interest cover also slightly increased to 3.6x at end-2011 from 2.9x at end-2010. Fitch expects that interest cover will remain in the low single-digit territory.

RATING SENSITIVITY ANALYSIS

Positive: Future developments that could lead to positive rating actions include:

– A positive change in Kazakhstan’s rating could affect MEDNC’s ratings if the link with the sovereign strengthens.

– Stronger links with the sovereign demonstrated by explicit state support (not expected) would be positive for the ratings.

– Enhancement of business profile (diversification and scale with only modest increase in leverage) could be positive for the ratings.

Negative: Future developments that could lead to negative rating action include:

– A negative change in Kazakhstan’s rating could affect MEDNC’s ratings.

– Reduction of S-E’s stake to less than 50% (assuming that a new shareholder does not offer meaningful financial support or capex funding) would be negative for the ratings.

– Deterioration in MEDNC’s FFO adjusted leverage to 4x and FFO interest cover to 2x on a sustained basis could put pressure on the ratings

LIQUIDITY & DEBT STRUCTURE

– Manageable Liquidity

Fitch views MEDNC’s liquidity as manageable, comprising solely cash as the company does not have any available credit lines. At end-Q312, MEDNC’s cash balance of KZT1.1bn was sufficient to cover short-term maturities of KZT0.9bn. Cash balances are mostly held in local currency with a local bank, which is a concern. At end-Q312, most of MEDNC’s debt was represented by two unsecured fixed-rate bonds of KZT800m each that mature in 2013-2014. The rest of the debt is represented by 25-year interest-free loans provided until 2009 by MEDNC’s customers to co-finance new network connections.

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